Lack of govt guarantee to push up cost of Air India’s $1.6 bn loan

Mumbai: Air India may have to pay more to borrow $1.6 billion (Rs7,456 crore) and start the whole process of fund-raising anew because the government is not willing to stump up a full sovereign guarantee as well as pledge aircraft as collateral for the loans, said a civil aviation ministry official and an executive at the national carrier familiar with the situation.

The airline, which needs the money to fund aircraft purchases, has received attractive offers from financial institutions, but the cost of borrowing will increase if either of the two conditions placed by the potential creditors isn’t met, said the two persons, who spoke on condition of anonymity.

A sovereign guarantee gives creditors the assurance that the government would step in to repay a loan if the borrower is unable to do so. The government is ready to offer a sovereign guarantee for Air India’s working capital loans; it’s willing to offer only a part guarantee for the term loans it wants to raise for buying aircraft, the two persons said.

In 2007, the national carrier had embarked on an ambitious fleet acquisition project, ordering 111 aircraft—43 from Airbus SAS and 68 from Boeing Co.—worth a combined $11 billion.

It has already raised at least $3 billion in loans from banks to fund the purchases.

According to the Cape Town Convention, an international treaty designed to facilitate asset-based financing and leasing aircraft, to which India is a signatory, a state-owned airline will have to both pledge aircraft as security and offer a sovereign guarantee while raising loans.

“The government is now asking Air India to furnish 100% aircraft security and part sovereign guarantee as collateral while raising the loan for aircraft financing,” said the ministry official. The objective seems to be to use part of the sovereign guarantee to raise working capital loans that carry relatively higher interest rates, he added.

Air India already pays at least Rs2,400 crore a year to service existing loans. The cash-strapped airline, which has accumulated losses of Rs14,000 crore in the last four fiscals, needs Rs18,000 crore of working capital loans from banks.

According to the Air India executive, the airline may not get attractively low rates when it seeks fresh bids from potential creditors for the term loan, but the rise in the cost of the loan would be offset by the lower-priced working capital loans.

“We will have to place a request with the financial institutions and export credit agencies to partly do away with sovereign guarantee...,” he said. The executive did not say when new bids for the loans would be invited from financial institutions.

Banks may draw comfort in lending to Air India from the fact that the national airline has been registering healthy seat occupancy and generating a rise of Rs150 crore in quarterly cash flow.

“The passenger revenue of the April-July period was up by 26.5% compared to the corresponding four months last fiscal. The cargo revenue also increased by 58.3% for the same time,” the executive said.

Meanwhile, Air India has come out with a tender for renewing its aviation insurance policies for the year 2010-11. Air India had an insurance cover of $8.9 billion for 153 aircraft for which it agreed to pay an annual premium of $24.23 million, with a consortium led by Anil Ambani’s Reliance General Insurance Co. Ltd.

Aviation insurance rates are likely to increase after an Air India Express flight crashed while landing at the Mangalore airport in May, killing 158 people in the worst airline accident in India in a decade. The Air India executive conceded that insurance would become more expensive given recent aviation accidents outside of India as well.

In May, T.A. Ramalingam, head of underwriting at Bajaj Allianz General Insurance Co. Ltd, told Mint that the claims stemming from the Mangalore crash will have a “big impact” on insurance rates. He also cited an increase in the number of smaller aviation-related claims in the past two years.

“Insurance rates are going to harden when aviation insurance policies come up for renewal,” said Ramalingam.

The Centre for Asia Pacific Aviation, an aviation consulting firm, in its mid-year outlook for Indian carriers released in July, said Air India is expected to post losses of $650-700 million this year.

“There are a number of positive developments under way. However, financial losses are expected to continue for the next few years because of deep-seated structural issues... The strength of market growth in terms of both domestic and international traffic will see the level of losses decline,” it said.

In late July, Air India unveiled a turnaround plan that envisages the airline reaching break-even and wiping out the Rs14,000 crore of accumulated losses and Rs18,000 crore of debt on its balance sheet by 2014-15. The plan includes raising its fleet strength to 275 in five years from 148 now.